BBC Source - Merkel: “Greece Will Default”

You have to take any comments relative to Europe with a grain of salt, but the source of the tweet below is credible.

As we outlined in the past, the levels of debt in Europe relative to tax revenues and capital needs for insolvent banks produce an unsustainable situation. Any additional funds given to Greece will most likely have similar outcomes to a flush of a toilet in the coming months. According to Bloomberg (01/28/2012), the Germans seem to agree:

Lawmakers from German Chancellor Angela Merkel’s coalition rejected increasing aid for Greece, Der Spiegel said, citing members of the parliament in Berlin. There can be no further aid if Greece doesn’t implement the agreed adjustment programs, the magazine said, citing Horst Seehofer, chairman of the Christian Social Union, the Bavarian sister party of Merkel’s Christian Democratic Union.

Recent reporting from the Guardian also seems to hint at a greater probability of default than what is priced in the financial markets. Excerpts from a January 25 Guardian interview with Angela Merkel are below:

Angela Merkel has cast doubt for the first time on Europe’s chances of saving Greece from financial meltdown and sovereign default, conceding that Europe’s first ever multibillion euro bailout coupled with savage austerity was not working after a two-year crisis that has brought the single currency to the brink of unravelling.

“We haven’t overcome the crisis yet. Of course, there’s Greece, a special case where, despite all the efforts that have been made, neither the Greeks themselves nor the international community have yet managed to stabilize the situation.”

“There would be no point in promising more and more money without tackling the causes of the crisis,” said Merkel. “Amid all the billions in financial assistance and rescue packages, we Germans also need to watch that we don’t run out of steam. After all, our capacities aren’t infinite, and overstretching ourselves wouldn’t help us or the EU as a whole.”

Note the ongoing mention of Greece being a “special case” in an attempt to stem the almost inevitable tide of contagion. As we showed graphically on January 27, the ever-increasing yield on Portuguese bonds is indicative of a market that also believes Portugal will be a “special case”. Euromoney also expressed concerns about contagion:

More worrying than any of this, the abrogation of the principle of equal treatment for all holders of the same class of security will come at a cost. No matter that there is no legal challenge to this. Good faith counts. As the Green negotiations wore on at the end of January, the price action in Portuguese government bonds became alarming, with yields on three-year bonds rising to over 19%.

Time and again the official sector has said that Greece is unique and that there will be no more cases of bondholders being asked to write off their loans. The market doesn't believe that any more. With the official sector protecting its own financial position and allowing the private sector to go hang, no one does. Portugal's government has said it will not ask for relief and points out that voters at the last election overwhelmingly backed parties championing austerity.

Let's see how they react when Greece gets a big slice of its debt forgiven.

Deal With Creditors Not End For Greece

Let’s assume Greece and its private creditors reach a “deal”. That deal is far from the final hurdle to preventing a Greek default. According to the Wall Street Journal:

A deal could pave the way for a second bailout package for Greece. However, there have been fresh warnings from euro-zone governments that Greece must improve the implementation of its austerity measures in order to get further assistance. Mr. Rehn has said the euro zone, the European Central Bank and International Monetary Fund may need to inject additional money for a second Greek bailout.

Once a Greek deal is done, an assessment of whether Greece’s debt is sustainable will follow. After that, its official creditors—other euro-zone countries and the IMF—will decide how much money is needed to fill Greece’s remaining financing needs.

The question then is how many of the €200 billion in Greek bonds will be tendered by private bondholders. If too many hold out, then the debt-sustainability sums won’t add up. Greece has said it could then move to force unwilling creditors to accept the bond exchange, transforming the deal from one that could be called voluntary to a coercive default.

Germany also appears to be adding one more significant hurdle according to the BBC:

A leaked plan from the German government proposes a eurozone “budget commissioner” to take control of Greece’s tax and spending, reports say. The Financial Times, which has a copy of the plan, calls it an “extraordinary extension” of EU control. Greek Education Minister Anna Diamantopoulou called the German plan “the product of a sick imagination”. The European Commission said the budget “must remain the full responsibility of the Greek government”. A German official told the Associated Press eurozone finance ministers were discussing the plan.

Portugal Ready For Center Stage

Portugal is Europe’s next big problem. According to the Globe and Mail:

Greece has been the debt crisis headline hog for months. This is unfair to Portugal, whose own financial nervous breakdown is getting uglier by the day, to the point that many economists and bond investors think a second bailout, a bond restructuring or outright exodus from the euro zone is inevitable. Most of Portugal’s key economic indicators are going in the wrong direction.

Spain’s economy contracted by 0.3 per cent during the fourth quarter, according to official figures, edging the country closer to a new recession as it deals with huge levels of unemployment and painful austerity cuts. The economy is expected to slide further through March, placing Spain back in its second recession in less than three years.

As far as the U.S. markets go, not much has changed. We still have conditions in place for some type of reversal/top. An S&P 500 close below 1,314.65 would bolster the bearish case.

Potential areas of support to watch include 1,285, 1,275, 1,260, 1,213, and 1,192. A weak bounce between 1,298 and 1,303 would fit well into the reversal case (a move with weak RSI).